The net operating cycle involves determining how long it takes to create inventory, sell inventory and collect on invoices to customers. For example, let's say Company XYZ makes widgets, which typically sit in the warehouse for 10 days. Let's also assume that it typically takes 15 days to collect on the sale of each widget, and that it takes 14 days to pay invoices to Company XYZ's vendors. Using the formula above, Company XYZ's net operating cycle is:

Net Operating Cycle = 10 + 15 + -14 = 11 days

This means that Company XYZ generates cash from its assets within 11 days.

Why it Matters:

The net operating cycle is a measure of how long an investment is locked up in production before turning into cash.

Changes in net operating cycle can be very telling. For example, when companies take a long time to collect on outstanding bills, or they overproduce and fill up the warehouse because they can't figure out what sells, their net operating cycles lengthen. For small businesses especially, long net operating cycles can be the difference between profit and bankruptcy. After all, companies can only pay for things with cash, not profits. In turn, the net operating cycle is a measure of managerial competency as well as operational efficiency.

It is important to note that different industries have different capital requirements and standards, and determining whether a company has a long or short net operating cycle should be made within that context.

CONTENT LIBRARY

InvestingAnswers is the only financial reference guide you’ll ever need. Our in-depth tools give millions of people across the globe highly detailed and thoroughly explained answers to their most important financial questions.

We provide the most comprehensive and highest quality financial dictionary on the planet, plus thousands of articles, handy calculators, and answers to common financial questions -- all 100% free of charge.

Each month, more than 1 million visitors in 223 countries across the globe turn to InvestingAnswers.com as a trusted source of valuable information.